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Strategy: Growth At What Cost?

I have offered my own Management Strategy and Entrepreneurship students my views on growth, from my career experience. My personal rule of thumb is that the ceiling for manageable growth of an established company is 25% per year. First or second year exponential growth rates do not apply here, and will quickly settle down. Growth approaching 20% is increasingly chaotic and nearly unmanageable. Growth over 25% is a recipe for a major management crisis or business failure. This article also focuses in on the issue of culture, which is now being seen as a fundamental driver of strategy, by leading academics like Professor Joel Peterson, at the Stanford Graduate School of Business, and not simply an outgrowth of good strategy and execution.

Professor Joel Peterson, Stanford Graduate School of Business

The following is a WordPress reblog from Methods Frameworks and their LinkedIn group page, Strategy & Corporate Strategic Planning Xchange. I strongly recommend joining this group on LinkedIn.

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Many startup companies are pushed and prodded by impatient investors or parent companies to achieve year-over-year growth targets…or else. When results from growth strategies do materialize, business leaders should celebrate the moment, reflect on the concentrated efforts their management team spent to accomplish the goal, then go back to work. At the first signs of success, it is not the time to abandon the methodology that led to the results…the hard work, the focus the organization maintained in the lean times and the painful lessons learned and applied along the way. The sweet taste of success in a company’s expansion strategy can tempt the business to become more brash in seeking out faster avenues for the next stage of growth – even before the foundational concrete of the current wave has fully set. This article takes a hard look at the cost of growth so that business leaders can develop growth strategies with their eyes opened to the risks and understand the costs that accompany accomplishing expansion.

The Price Of Growth

Growth is a bi-product of success and success is a bi-product of effective planning, diligent hard work and excellent management. While achieving growth is arguably the point of being in business, the terms of success in business expansion must first be defined and the risks well understood in order for them to be managed. Only then can expansion strategies provide lasting beneficial outcomes for the business. There is a common misperception that business growth means that the organization’s management team will be grappling with the same problems they’ve encountered in the past…but on a larger scale. That is hardly the case. Instead, the reality of successful growth means understanding, adjusting to and managing a whole new set of challenges—in essence it boils down to learning to manage a very different business.

In Andrew J. Sherman’s 1997 book The Complete Guide to Running and Growing Your Business, he stated: “Growth causes a variety of changes, all of which present different managerial, legal, and financial challenges. Growth means that new employees will be hired who will be looking to the top management of the company for leadership. Growth means that the company’s management will become less and less centralized, and this may raise the levels of internal politics, protectionism, and dissension over what goals and projects the company should pursue. Growth means that market share will expand, calling for new strategies for dealing with larger competitors. Growth also means that additional capital will be required, creating new responsibilities to shareholders, investors, and institutional lenders. Thus, growth brings with it a variety of changes in the company’s structure, needs, and objectives.” Sherman went on to say, “the need of the organization to grow must be tempered by the need to understand that meaningful, long-term, profitable growth is a by-product of effective management and planning.”

Not only can price of growth be high, the odds are stacked against fully satisfying growth expectations. For this reason, businesses must assiduously put to full use their planning and management disciplines in carefully targeting growth opportunities and follow through with them when executing expansion strategies.

Are We Ready To Grow?

Business growth is about finding opportunity. Unfortunately, identifying growth opportunities is not as easy as it sounds. Thomas Edison once said, “Opportunity is missed by most people because it is dressed in overalls and looks like work”.

Define Success and Understand The Risks To Be Managed

Business growth opportunities take on many dimensions and the success criteria for expansion should be defined in advance in order to plan towards accomplishing growth targets. Among other metrics, growth may be measured in terms of profits, revenues, market share, brand, stock valuation as well as political, community and industry influence. Regardless of the measurement used, business expansion is a stage of a company’s life that is fraught with both opportunities and perils. It is a pivotal point that tests the business model, the management team and the organization’s culture.

So how does an organization know when it is ready to take on a growth strategy that is more aggressive than organic expansion? Organic growth comes by offering strong value to customer markets — and that is the key to evaluating opportunities to expand through more energized growth strategies. Will the expansion opportunity lead to increased value creation for the market segments the firm is serving or targeting? Can the business execute on the plan?

Are the market segments viable for profitable growth to occur? This question is key, as high cost growth in a declining market is always a bad strategy. Look at Borders Books and Blockbuster Video as examples of companies with failed expansion strategies launched in the midst of significantly shrinking markets.

A business must also have its house in order and be on a path to continuous improvement for the seeds of growth to have fertile ground to take hold. Having the house in order includes having a culture that is passionate about quality, value and improvement. Andrew Grove, former CEO of Intel Corp, created a culture within Intel that allowed innovation and growth to flourish. As CEO, he wanted his managers to always encourage experimentation and prepare for changes, making a case for the value of paranoia in business. He became known for his guiding motto: “Only the paranoid survive,” and wrote a management book with the same title. According to Grove, “Business success contains the seeds of its own destruction,” believing that success breeds complacency and complacency breeds failure. Grove urged senior executives to allow people to test new techniques, new products, new sales channels, and new customers, to be ready for unexpected shifts in business or technology. Biographer Jeremy Byman observed that Grove “was the one person at Intel who refused to let the company rest on its laurels.”

The German philosopher Friedrich Nietzsche proposed that civilizations that were placid and predictable were in the last throes of their existence, while highly contentious and dynamic cultures were entering their growth phase. The same premise can be applied to businesses. Those experiencing complacency are likely in decline, whereas more dynamic organizations that consistently challenge the status quo are more likely to begin growth. Nietzsche’s point was that “while most civilizations pander to the former, the future belongs to the latter”.

Approaches To Achieving Growth

There are many viable routes that can be taken to grow a business. Growth may be accomplished by acquiring or merging with another existing business. Alternatively, growth may be realized through the development of new products, solutions or services. In other cases, franchising a successful business model or licensing intellectual property can propel growth. Growth opportunities most likely exist within the business itself through process improvements and innovation networks within the enterprise’s functional areas. Therefore, the search for opportunity should begin from the inside of the business and work outwards in a quest to optimize value creation. Build a successful business through the development of increased capability and capacity, then build again upon that successful platform.

Since there are enumerable methods to grow a successful company, how does a business pick a growth strategy? The answer depends upon the strengths and weaknesses of the organization. If innovation is a particular strength, it might be the winner. If it is not a perceived strength or is even considered a weakness – new services, solutions or product development as a means to grow is likely to be expensive and ultimately unsuccessful. In any chosen strategy, a critical success factor will be taking a realistic assessment of current-day capabilities and competencies that will be leveraged in growth planning and execution. A second success factor is to avoid compromising the successful core elements of the business that are currently working well.

To illustrate the importances of those success factors, let’s explore one of the most common growth strategies companies utilize and discuss pros and cons.

Merging or Acquiring

In business expansion achieved through the acquisition of a smaller firm, the benefits can potentially be realized relatively quickly, making it an attractive strategy for many businesses. However, the cost of growth through this approach is certainly far higher than the M&A transaction price paid. Certainly the M&A growth avenue is one of the most common, yet it comes with a hidden price tag.

The challenge is that business playing field changes dramatically when organizations combine and the stakes are raised significantly. Where in the past the organization likely maintained a laser-like focus on the operational details of providing superior solutions / products / services, there will now be new challenges that will syphon away some of that management attention. Whether it is the revamping of the combined organization’s market and brand image, the integration of manufacturing systems, the learning curve of a new line of business or dealing with cultural clashes within the combined organizations…distractions can and will help dilute management’s focus. That can lead to problems. A poor job done in integrating the two organizations could result in process breakdowns, unsustainably high fixed costs, poor quality and lost customers.

Just as innovating requires a competency for organizations to develop and master, integrating another business into the fold of a mature organization requires skill as well as careful planning. There are significant risks associated with acquisitions, beyond simply overpaying. In fact, it is hard to name many business maneuvers that are as risky and complex as mergers or acquisitions. The statistics show a very low success rate (consider reading Mergers and Acquisitions: Examining the M&A Ecosystem).

The IBM Approach

Regardless, many companies follow an acquisition strategy to stoke the pipeline with innovative new products and services and some have defied the odds – making this strategy a success. As a colleague once pointed out, companies like IBM buy a lot of companies annually and are pretty good at integrating the innovators quickly. The point was valid. In fact, IBM’s venture capital division works with top-tier venture firms across the world and is aligned closely with its corporate development group. This group is responsible for the firm’s M&A strategy. As a result, IBM has acquired more than 100 companies in the last decade, and the firm’s venture capital group had relationships with 40 of these companies and their venture investors. Using this process of working with young, innovative companies, IBM has been able to identify new products and technologies that its R&D group hasn’t thought of yet or developed.

Other Factors To Consider

One might assume that it boils down to the classic “buy vs. build” decision, where “buy” equals acquisition of a company for its innovation capabilities or cutting edge offerings. In this case, “build” relates to developing innovation from within the existing company’s creative workforce. While it may seem that simple, it isn’t. Companies following an acquisition strategy need to have a game plan for either integrating acquired companies or leaving them as stand-alone subsidiaries from which they can farm innovative creations. The problem with integration is that can be difficult to pull off successfully. Buying a company is not like purchasing a piece of software that can be expected to behave in a precise way that will meet our specifications. Instead, we are likely dealing with the integration of two very different cultures, and the human capital element in that mix is far from predictable. You do not know going into the acquisition if the entrepreneurial spirit that led to the innovations of the target company will survive an integration effort and persist to lead to more valuable creations in the future.

For an example, look no further than the HP acquisition of EDS. As pointed out by CRN, “the cultural clash within the combined organizations has been a 24-hour-a-day, seven-day-a-week nightmare for the EDS workforce since HP paid $13.9 billion for the outsourcing business in 2008”. HP even dropped the EDS name, a one-time gold standard for outsourcing services, in favor of an HP Enterprise Services branding.

That leads to a second point. Even if acquisition is the chosen strategy, without a fundamental understanding of and appreciation for the risk-taking innovation style of the purchased company – how can they be successfully managed so as not to squelch the creativity inherent in their culture? One approach is to make sure that the acquired company is left alone to be entirely autonomous, protecting the formula for innovation they have developed and insulating it from the dominant culture and politics of the parent company. But with no attempt made to integrate the firm into the parent company, will the full benefits be realized?

That said, the purchase price and integration challenges should not be a deterrent if the following are all true:

The acquiring business possesses the management strengths to integrate the acquired firm and so long as

The acquiring business has the financial means available

Due diligence suggests that the expected return on investment will ultimately be realized

Concluding Thoughts

Growth occurs naturally when value is created through a company’s offering of superior solutions / products / services. The focus on value creation through this avenue is the first step towards accomplishing meaningful growth. For this reason, maintaining or shrinking in focus is sometimes required to get the business’s offering optimized and achieve superiority to competitors in the market.

Secondly, innovation is still the key ingredient for growth. Whether innovation originates internally or is acquired from the outside, it must be present. Innovation doesn’t always mean new products, but can come by creating operational efficiencies as well.

Lastly, remember that growth must be planned, managed and paced. Sometimes a base hit is better than swinging for a home run and striking out.

2 Comments on “Strategy: Growth At What Cost?”

Thanks, David – a thorough discussion of growth techniques.
I always wonder, contrary to a point you make above, why is growth a necessity in business? If successful by financial means, what forces (besides the drive of owners) business growth? What makes growth the point of being in business?

Andrew, it is very poignant that you raise the question about the necessity of growth in business. Stanford has raised this question to its business school people for some time, perhaps because it seems counter to everything we expect about business. I have a dear Silicon Valley friend and Stanford Business School grad who educated me about maintaining a “stasis” business… There are many varieties of entrepreneurial endeavor.

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David Mayes

Founding Partner, Vendange Partners, UBC adjunct faculty, Intel alumni, technology assessment, international business, clean tech, fly fisherman, native Californian and citizen of France, who has been very fortunate to have traveled, lived and worked all over the globe. My wonderful wife, Isabelle has reintroduced me to my French Provencal heritage.